The Pain (and Pleasure) Of The Dollar’s 20-Year High

On a trade-weighted basis, the US Dollar has charged to its highest level in two decades. The consequences of that surge stretch far beyond the US financial system, and US investors.

The US Dollar is the world’s most liquid currency – and by some measure, it could be described as the most liquid asset in the world. For an asset with such ubiquity, extremes in value can result in serious complications for the health of the global financial system, at a time of instability. Regardless of what asset type or country your investment focus, it is important to monitor the health of the Greenback moving forward.

It is worth noting that the Dollar – as measured by the trade-weighted index from the ICE – has surged nearly 20 percent in the past 16 months. That has pushed the benchmark to its highest level in nineteen-and-a-half years and through the 38.2 percent Fibonacci retracement of the historical range from the February 1985 peak to the March 2008 trough (at 106.61) for the chart gazers amongst us.

The incredible run from the Dollar can confer benefits to certain players. In a world where inflation is seen as one of the greatest threats to worldwide growth and market stability, a rapidly rising currency can help curb painful hikes in cost for goods and services that consumers and businesses face. Furthermore, a stronger US currency against principal counterparts – like the Euro and Japanese Yen – can stretch the purchasing power of Americans buying foreign goods.

The Pain of a More Expensive Dollar for the World

While it is possible to identify some silver linings in the Dollar’s sky-high climb, the costs are far more pervasive and important for the world. Consider that many of the world’s most important commodities which fuel growth are priced in the US currency. Purchases of necessary goods like crude oil or copper require conversion to the expensive currency before consuming the end goods. And, in this case, both the currency and raw materials have increased in cost. This is an unwanted dynamic in an environment where ‘recession’ is on the lips of so many investors, economists and government officials.

Another detrimental side effect of an expensive Dollar is the struggle inflicted upon economic peers – particularly emerging markets – that have borrowed funds via USD. In a recent evaluation of the Dollar’s top world status, the New York Fed reported that the Dollar is the most commonly held denomination among external bank assets to the tune of $16.7 trillion. Foreign interests repaying loans taken out just a year ago will have seen their financing burden rise sharply.

A New, Dollar-Forged Trade War?

What’s more, the rise in USD versus its largest counterparts, raises the pressure of protectionist perspectives among trade partners. If European or Chinese companies, for example, find the demand for their goods among US consumers is evaporating, the pressure to exact polices ‘at the expense of trade partners’ can swell. That is the kind of pressure that can push the world back onto a protectionist course – the type of path that has contributed to our current economic malaise. In such an environment, ‘risk assets’ tend to generally suffer.

Ironically, the strong Dollar erodes the currency’s safe haven appeal. There is no viable singular alternative (the second most liquid currency, the Euro, has generated significantly less use worldwide), but that only ensures pain will be distributed. Further, when the measures that we rely on for stability become themselves volatile, the entire system is considered even more risky.

Will Authorities Watch the Fallout and What Can Traders Do?

So what can and will the world—and investors—do about their USD problem? It is unlikely that the world’s authorities (central banks, governments, regulatory agencies) will simply ‘hope’ for moderation if the charge continues. Overall, it is difficult to steer the most influential cog in the system, but it is certainly possible when approached with a collective policy regime. As an example of how an effort can be mounted across powerhouses to address overwhelming situations like this, we can reference the G7’s collective currency action to halt the Yen’s persistent appreciation follow the Fukushima disaster in 2011.

It is worth keeping a close eye on the Dollar’s climb and all efforts to draw attention to the ‘abnormality’ of the move by these authorities as a warning sign that either economic fallout or interventionist action is on the horizon. In more discrete terms, one-sided moves like that from USDJPYPY
draws on ever greater risks to prompt a reversal.